August 14, 2022

How the Supreme Court’s EPA Decision Could Shape the Future of Web3

By Tomicah Tillemann, JP Schnapper-Casteras, and James Rathmell

This season, the Supreme Court is producing a plethora of headlines and national controversy. Amid the firestorm and fallout, it would be easy for technologists to overlook a recent decision concerning the authority of the Environmental Protection Agency (EPA) to regulate carbon emissions. That would be a mistake.

At first glance, West Virginia v. EPA seems to be about nothing more than a set of effectively obsolete emissions-reduction regulations from 2015, known as the Clean Power Plan. But, upon closer inspection, this case is the latest in a series of judicial decisions that are fundamentally changing the rules of the game for regulatory agencies across the federal government. Setting aside the merits of the Court’s decision, it’s important to map the potential implications of this sea change for technology policy.

First, some background: West Virginia v. EPA involved a group of states and power companies challenging the legality of the 2015 Clean Power Plan, which set nationwide carbon dioxide emissions standards for power plants and required plants take steps to meet them. In its simplest form, the dispute boiled down to whether Congress, in passing a particular statute 50 years ago, properly gave the EPA authority to establish the Clean Power Plan in the first place.

At the top of the Constitution, Article I, Section 1 reads: “All legislative Powers herein granted shall be vested in a Congress of the United States.” Over the years, Congress has passed a range of statutes setting up federal agencies like the Food and Drug Administration (1906), the Federal Trade Commission (1914), and the Securities and Exchange Commission (1934). At the same time, the Supreme Court has decided a number of cases interpreting Article I, Section 1. In the early 20th century, these co-developments culminated in a legal theory called the nondelegation doctrine, which says that, “Congress is not permitted to abdicate or to transfer to others the essential legislative functions with which it is thus vested.” Put simply, Congress must make the law (pass statutes), and agencies must execute that law.

Of course, it turns out to be a bit more complicated than that: Congress sometimes passes laws with broad language or loosely defined terminology; other times, Congress explicitly directs federal agencies to create regulations with more technical details down the line. The complexity of our society and economy have caused courts to interpret the nondelegation doctrine liberally over the past hundred years — and to largely defer to agencies on the grounds that they possess more specialized knowledge of certain subject matter within their domain. As the dissent explained in West Virginia v. EPA:

Members of Congress often can’t know enough—and again, know they can’t—to keep regulatory schemes working across time. Congress usually can’t predict the future—can’t anticipate changing circumstances and the way they will affect varied regulatory techniques. Nor can Congress (realistically) keep track of and respond to fast-flowing developments as they occur. Once again, that is most obviously true when it comes to scientific and technical matters. . . . Over time, the administrative delegations Congress has made have helped to build a modern Nation.

In practice, agencies in the executive branch such as the SEC, CFTC, and many others have played an increasingly consequential role in shaping freestanding bodies of regulation. Collectively, these rulemaking agencies are sometimes referred to as the administrative state.

The expansion of the administrative state in the 20th century hasn’t been without its critics among academics and jurists, including some current members of the Supreme Court. These critics have produced another legal theory: the major questions doctrine. The major questions doctrine says that Congress must make a clear statement if it wants to give an agency authority to make decisions of “great economic and political significance.” This doctrine is emerging as an important force in the world of administrative law by breathing new life into the nondelegation doctrine.

Applying the major questions doctrine, the Supreme Court in West Virginia v. EPA held in a 6-3 decision that Congress had not provided clear authority for the EPA to pursue the Clean Power Plan. Nationwide energy production and usage is a matter of “great economic and political significance,” the majority explained, which would have required Congress to unequivocally empower the EPA to implement this particular regulatory program. Moreover, the Court reasoned, the Clean Power Plan proposed by the EPA was similar to regulatory schemes that Congress “had already considered and rejected numerous times.” Overall, the Court highlighted its skepticism towards the notion that a regulatory agency could “discover in a long-extant statute an unheralded power representing a transformative expansion in [its] regulatory authority.” (The three dissenting members of the Court explained how they would have interpreted Congress’ language quite differently and criticized the majority for “announc[ing] the arrival” of the major questions doctrine, which it saw as unprecedented and “tougher-to-satisfy.”)

This majority decision indicates that, at the highest levels, the federal judiciary is increasingly scrutinizing aspects of federal agencies’ plans and rulemaking in the absence of clear congressional action. Although West Virginia v. EPA tackled the enduring problems of climate change and national energy supply, nowhere is this jurisprudential evolution likely to prove more consequential than the regulation of emerging technologies such as web3 — the platinum standard of an industry defined by “fast-flowing development.”

Even at this early stage, web3 is already demonstrating its potential to have “great economic and political significance” by changing Americans’ relationship to technology and capital. Recent polling data shows that over 20% of Americans have now invested in, traded, or used digital assets. The web3 sector is poised to reshape the business model of the internet, along with trillions of dollars in market capitalization; it may likewise transform the landscape of public goods funding, governance, and capital formation.

Moreover, web3 is a fundamentally different technology paradigm that sometimes transcends the policy objectives underpinning existing regulatory regimes. To take one example: traditional financial regulation seeks, among other things, to correct information asymmetries between insiders and the public with the goal of putting everyone on equal footing. For web3 projects — many of which are open source and designed to replace corporate intermediaries to ensure that everyone is on equal footing from the outset — the appropriate regulatory architecture is less clear. It is no wonder that Congress has already considered and failed to enact a number of statutes relevant to web3: the Online Market Protection Act of 2014, the Managed Stablecoins are Securities Act of 2019, and the Crypto-Currency Act of 2020, among others.

With the highest court in the land endorsing an expansion of the major questions doctrine, federal agencies will likely take pause. Hermeneutic interpretation of old statutes motivated by old policy objectives has become a less viable path for sweeping regulation of novel technologies that present novel policy questions. Agencies can and should advance regulatory clarity by focusing on issues clearly within their purview, but they may become more careful when Congress has already considered and rejected a proposed regulatory regime. Market participants, litigators, and regulators alike will probably find themselves taking a second look at whether the text of a given statute unambiguously authorizes an agency to take broad measures.

The corollary is that Congress needs to speak clearly in any legislation that grants federal agencies major regulatory or oversight authorities over a new sector. In some instances, Congress may decide that new technologies should still be governed by old rules — but they must explicitly say so. In other instances, they may define a new policy architecture that is fit for purpose, rather than attempting to shoehorn technological breakthroughs into century-old statutory frameworks. Either way, greater statutory and regulatory clarity will benefit all involved.

These political and legal dynamics dramatically increase the importance of the web3 legislative proposals that will likely come before Congress next year. Many leading indicators of future legislative activity are hopeful. Several recent examples of legislation introduced in the Senate (by Senators Stabenow, Boozman, Lummis, Gillebrand, Toomey, Sinema, Warner, and Portman), along with an anticipated stablecoin bill in the House (that will likely be authored by Representatives Maxine Waters and Patrick McHenry), all offer evidence of meaningful bipartisanship, real consultation with stakeholders, and thoughtful efforts to realize the potential of web3 technology. Web3 is the rare domain where Congress could actually deliver bipartisan statutes that match the moment.

As we know from the last century of innovation, well-crafted legislation can empower effective regulation, with vast benefits for American economic prosperity, global influence, and consumers. But successful statutes from the past are not the only roadmap for the future, particularly when it comes to web3, nor is piecemeal rulemaking and enforcement the path to mission-critical policy for the next generation of the internet. Ultimately, we'll need new rules to help govern these new tools.

September 8, 2022

Digital Assets and Gary Gensler’s Historical Spin

By Chris Lehane

Securities and Exchange Commission Chair Gary Gensler recently asserted that when it comes to digital assets, the federal government can rely on rules that have applied to the financial markets since the 1930s. No need for new ones. Gensler pointed to the Motor Vehicle Safety Act, signed into law by President Lyndon B. Johnson in 1966, to make the case that laws passed to protect consumers decades ago can keep protecting them even as “new technologies come along.”

Chairperson Gensler, your own example, when not drawn so narrowly, is in fact one of government support for private-sector technological innovation that helped position the US as a global economic force equipped to help preserve democracy. Let’s quickly review the history of the car:

Over the course of the 1800s, European inventors worked on what were then called “mechanically propelled vehicles.” Early proponents envisioned cars ushering in the democratization of travel at scale and a fundamental transformation of how people lived, worked and moved around—to say nothing of how food could be delivered without rotting, and supply chains could be expanded and diversified.

Skeptics scoffed at the clunky technology. Critics doubted people’s capacity to operate and maintain it. And governments, some beholden to deep-pocketed legacy companies of the time, pointed to a lack of suitable roadways to justify using regulations to block it.

In the UK, where some of the earliest cars were introduced, growth of the nascent industry was stunted by the 1865 passage of what was called the Red Flag Act, which required three people per vehicle, one of whom had to walk ahead of it with a red flag (doable because of another requirement—that cars move no faster than 4 MPH) so as to warn others on the road and wave the car aside to make way for horse-drawn transport.

Across the Atlantic, however, a young country busy transitioning from a pre-Civil War agriculture-based economy into a global industrial powerhouse took a very different approach—one that merged private-sector innovation and imagination with public-sector enlightenment and creativity to figure out how to best unlock new technologies to advance the common good.

Henry Ford (despite his flaws) made the US the global heart of the auto industry, mass-producing affordable cars in collaboration with open-minded local, state and federal officials. Public health and safety concerns over horse-drawn vehicles in increasingly crowded cities moved local officials to support the switch to cars. The vastness of the US prompted states to invest in better roads.

And at the federal level, auto industry regulation did not begin in 1966 with the Motor Vehicle Safety Act—it started in 1916 with the passage of the Federal Aid Road Act with policy actions designed to support the scaling of car transportation.

The big-picture lesson here is the progress made possible by partnership between an innovative US private sector and an enlightened public sector:

  • Led by Ford but joined by others, the US became the global hub of the auto industry, eventually embodied by the “Big Three.”
  • A new model for industrial production emerged: the assembly line.
  • This new model helped the United States become one of the world’s largest economies.
  • Our economic and manufacturing might was later foundational to America’s ability serving as the “arsenal of democracy” during the Second World War.
  • The approach of the Big Three, impact of New Deal labor policies, and the efforts of the United Auto Workers, Teamsters et al ensured that a fair day’s work paid a fair day’s wages and resulted in a generation of post-World War II Americans who entered the middle class and juiced the network effect of a consumer economy.
  • It was ultimately the strength of the dynamic US economy that overpowered the Soviet Union.
  • And, as we are seeing today in California and in the recent federal climate legislation, this partnership between a forward looking public sector and a creative private sector continues to be critical – resulting in the positioning of the U.S. as a global leader in the transition to the next generation of cars – electric vehicles (including the production and manufacturing).

Chairperson Gensler, if we’re going to look to the history of tech policymaking, the real lesson is that the 20th Century did not become the American Century through the waving of red flags. Instead, it was government’s embrace and cultivation of innovation that encouraged builders to build for the benefit of the nation’s economic security and national security.

LBJ may have signed the Motor Vehicle Safety Act in 1966, but that same year, he also previewed the establishment of the Department of Transportation with a nod to how “[e]nlightened government has served as a full partner with private enterprise in meeting America’s urgent need for mobility.”

Much as the car was a technological inevitability, so is the next generation of the web. If we’re going to look backward for lessons on how to proceed on digital assets, let’s make sure they are lessons that lead us forward, not lessons that keep us mired in the past. And as we think about the role of digital assets and the next chapter of the Internet, the key takeaway here is that when a creative government partners with responsible builders the winner is the common good.

October 18, 2022

OFAC Cannot Shut Down Open-Source Software

By Katie Haun and James Rathmell

Since our post last month, there have been some further developments in reaction to the Tornado Cash sanctions, from Coinbase’s lawsuit to Treasury’s clarifying guidance and Coin Center’s complaint. We’re glad to see a strong response from the industry because we believe foundational principles are at play in this case. Namely, can governments ban open-source technology with sanctions, proscriptions, or embargoes that aren’t narrowly tailored? OFAC is right that many criminals have misused the Tornado Cash platform, but the stakes here go beyond Tornado Cash. The real question is whether the government can target the architecture of a blockchain itself, because what can be done to one kind of open-source protocol can be done to any open-source protocol.

I say this as someone who spent a decade prosecuting money launderers: the fight against illicit finance must be done in a way that’s legally sound. There’s a tried and true playbook for addressing money laundering if there exists sufficient evidence of intent to subvert the law — bringing prosecutions, enforcement actions, seizures, and other steps against bad actors.

Here, OFAC sanctioned Tornado Cash based upon IEEPA, a federal law that gives it the authority to block “any property in which any foreign country or a national thereof has any interest,” alleging that the protocol had been “commonly used by illicit actors to launder funds, especially those stolen during significant heists.” OFAC’s concerns in this respect are undoubtedly legitimate. But in issuing broad, indiscriminate sanctions against an open-source protocol writ large, the agency overstepped its legal authority to sanction the foreign hackers and their property in a way that leaves it exposed to both statutory and constitutional attack. It’s also produced a chilling effect for plenty of builders in the space who are rightly concerned whether OFAC’s view is now the law.

We don’t think it is.

Today, we’re publishing a legal memo that open sources the core arguments as to why, which we hope will be used in existing cases and ones still to come. When we thought about who to collaborate with on these arguments, Steve Engel was the first person who came to mind. Steve and I were co-clerks at the Supreme Court and he went on to lead the Office of Legal Counsel, the office that reviews the President’s executive orders for legality and also effectively serves as outside counsel for all executive branch agencies, including Treasury (read: Steve doesn’t hang out on crypto twitter so I called him up, explained the situation, and we brainstormed a bit).

The bottom line is that we think that OFAC went too far as a statutory matter because it appears to have blocked open-source, self-executing software that isn’t a person or the “property” of any foreign national or entity. IEEPA doesn’t grant such broad, roving authority to target open-source software architecture, and that is true no matter how noble OFAC’s intentions may have been. As the Supreme Court said in a recent case, our system of government “does not permit agencies to act unlawfully even in pursuit of desirable ends.”

What’s more, the agency has exposed itself to constitutional attack on a few fronts. It’s likely a court may not even reach the constitutional questions, however, because of the doctrine of constitutional avoidance which instructs courts to avoid ruling on constitutional issues when a case may be resolved on other statutory grounds. As the Supreme Court noted recently, the constitutional-avoidance canon provides “extra icing on a cake already frosted.” But suffice it to say these sanctions resulted in an asset freeze that deprived some innocent Americans of their property—without due process of law. And the sanctions may have violated the Fourth Amendment’s prohibition on unreasonable seizures to boot. Finally, while OFAC’s recent guidance shows that it recognizes the First Amendment problems inherent in altogether banning the publication of and interaction with code, its prohibition on the use of Tornado Cash code burdens the ability of Americans to use the privacy-enabling application to facilitate anonymous speech. That itself raises a substantial First Amendment issue.

Speaking of extra icing, sanctioning open-source code is also bad policy. These sanctions are reminiscent of when the U.S. government attempted to curtail public access to encryption tools in the 1990s by banning the export of encryption technology. Had the U.S. criminalized the use of cryptography without a license, we would have a much less secure — and much less developed — internet today.

We think that OFAC has overstepped, and it should fix that sooner rather than later. The first Tornado Cash lawsuits have already been filed against OFAC in Texas and Florida, and these may not be the last. OFAC can and should focus its sanctions efforts on the bad actors who abuse open-source software, not on the tools themselves.

The full memo can be found here.

October 31, 2022

New Rules for a New Thing: A Petition for CFTC Rulemaking on DAO Participant Liability

By James Rathmell

The CFTC’s recent enforcement action against Ooki DAO is the latest example of why regulation by enforcement is bad for the rule of law. Everyone should want more responsible governance in web3, not less. DAOs represent a new democratized model for governance—one that empowers community participants to actively engage in collective decision-making and better align stakeholder interests. DAOs help unlock a decentralized and economically distributed framework for technology development.

Rather than encouraging this innovation, the CFTC has taken a big step backwards. From what we’re seeing and hearing, the fallout from the action has been to inject fear, uncertainty, and doubt among builders and participants. The CFTC’s legal theory acts a bit like a sword of Damocles over DAO participants—any tokenholder who votes her tokens, even if she votes against a proposal later deemed unsound, even if she votes and then later disposes of her tokens, could potentially be held liable under the CFTC’s theory. Another way to think about it: imagine every contributor to Wikipedia, past and present, was held personally liable for a copyright violation on the platform.

Until the CFTC issued its order, the web3 community had no meaningful notice that the act of voting tokens could expose a tokenholder to significant personal liability. That lack of notice is a big problem: many protocols governed by DAOs were built with minimum voting thresholds. If tokenholders stop voting en masse, it could become impossible to update a protocol; or, worse, it could become impossible to patch the protocol in light of vulnerabilities, creating an attack surface. Tokenholders’ fear of participating in DAOs due to the CFTC’s aggressive approach to DAO-participant liability could severely restrict this nascent but flourishing technological innovation in the United States.

Given the impact on innovation, we think it’s important for the industry to engage here. There are two obvious paths that we see.

One path is litigation. As part of a legal defense, Ooki DAO’s members will be able to raise some of the arguments alluded to above because they have what is called standing, a legal doctrine which limits who can file lawsuits. Interested third parties can also get involved in litigation by filing amicus briefs to make their voices heard. (Our friends at Paradigm did just this—recommended reading.) But civil litigation is a long and arduous path that could take several years to wind its way through the court system, courts can disagree with each other, and the uncertainty from all of this could cast a long chill over web3 development.

Another path is to go through the administrative process, which has specific rules around filing a petition for rulemaking. That’s why, today, we petitioned the CFTC to initiate a rulemaking process and promulgate a regulation to provide certainty related to the activities of individuals participating in DAO governance, including specific text for a rule we think the CFTC might adopt to limit DAO-participant liability. Given that the leadership of the CFTC has, to its credit, generally adopted an open-minded and constructive approach to web3, we’re hopeful the CFTC pursues such rulemaking. This would be consistent with its statutorily mandated mission “to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.”

The ball is now in the CFTC’s court to take whatever action it deems appropriate, and it will have to notify us of its decision. There could be a notice and comment period, during which the agency would solicit public input on the prospective rule. If it denies our petition, it will have to explain why. Our sincere hope is that this petition causes the CFTC to prioritize proactive rulemaking to provide clarity to web3 builders and participants versus just regulating by enforcement.

There will always be bad actors who will attempt to use new technology for illicit purposes, and CFTC and other government agencies may sensibly enforce the laws against them. But we think, by and large, there are far more people who try to use new technology for good than for ill. We think the CFTC should engage with the communities behind the many DAOs that are already, even at this early stage of innovation, having a positive impact on the world.

We hope this petition can reorient them in that direction.

Rachael Horwitz, Chris Lehane, and Tomicah Tillemann, contributed to this post. Thanks to Shahab Asghar, Brandon Neal, Marc Boiron, Rebecca Rettig for feedback.

November 4, 2022

Our Response to the Treasury Department’s Request for Input from Web3

By Tomicah Tillemann, Chris Lehane, and James Rathmell

Yesterday, we submitted extensive comments in response to a request for input from the Treasury Department. The agency is looking for help figuring out how to support the development of digital asset technology without enabling bad actors. As a reminder, an Executive Order issued by the White House in March assigned the Department responsibility for quarterbacking elements of the government’s broader web3 strategy.

To date, much of the agency’s focus has been on managing potential risks related to money laundering and illicit use of digital assets. We think that’s the wrong starting point for a conversation about how policymakers should engage with web3. Our response, available in its entirety via this link, is built around three main points:

  • (1) The current financial system is failing to meet the needs of millions of Americans and billions worldwide. Consumers are currently spending $46 billion on anti-money laundering protections that only stop 0.2% of illicit financial flows. At the same time, the system is preventing millions from accessing basic financial services. Many legacy systems simply aren’t working the way they should.
  • (2) Web3 technologies can provide significant improvements over a broken status quo. Programmable assets can bring new functionality to finance. For example, emergency relief funds could be programmed for use on food or housing or designed to decrease in value over time, thereby reducing the potential for inflation. ZK proofs offer better solutions for preserving privacy. And digital assets in general provide a new infrastructure with the potential to be far more efficient, inclusive, and innovative than the antiquated systems currently used for moving money.
  • (3) Given the benefits of web3 architecture, the Treasury should prioritize responsible collaborative efforts with the private sector. The infrastructure of the internet and global finance is going to change. That much is clear. The question is whether the United States and other open societies can leverage web3 to provide serious alternatives to the sophisticated systems emerging from authoritarian regimes. That’s still an open question, and the answer will depend on regulators working together with technologists and industry.

We suggest that the Treasury Department take specific actions including building policy around consultative rulemaking rather than punitive enforcement, encouraging development of open standards for privacy-preserving digital identity, and embracing open-source innovation as an alternative to closed, centralized systems. Fostering the responsible growth of web3 is one of the most important steps the United States can take to ensure its strength and competitiveness in the 21st century. Our engagement with Treasury is one of many ways we’re working to help policymakers understand and embrace that potential.

February 1, 2023

All Eyes on the U.K.: Crypto on the Thames

By Chris Lehane and Tomicah Tillemann

Crypto founders have spent years asking policymakers for regulatory clarity. That goal got closer this week—just not in the United States.

There has been a lot of noise, finger-pointing, and posturing about crypto regulation in the wake of several high-profile meltdowns in the industry. In the absence of meaningful new legislation—a.k.a. new rules for new things—many American officials continue to pursue regulation by enforcement, a posture that’s been unhelpful for builders working to create innovative, compliant products and services in web3. These recent trends are disappointing, but there are bright spots emerging overseas.

By abdicating its position of regulatory leadership, the U.S. is creating opportunities for policy arbitrage. Other countries are stepping in to provide needed regulatory clarity and protection for consumers. That’s why we’re monitoring the United Kingdom’s early, encouraging efforts to develop web3-friendly policies. There are still a lot of questions to be answered about how the rules in the U.K. will evolve, particularly around DeFi and stablecoins. However, the British government made an important announcement about their intention to provide regulatory clarity for digital asset projects in the U.K. this week. We are working closely with our portfolio to capitalize on this progress.

What’s Happening

The U.K. has taken a meaningful step toward a post-Brexit regulatory update for its financial sector that looks to be a sincere, serious effort to transform Britain into a global hub for digital assets. Today, U.K. Treasury official Andrew Griffith announced the beginning of what will likely be a rapid process to develop and formalize comprehensive rules for digital assets. This is the beginning of a consultative process, not the end. Many of the details still need to be finalized before we will know the full impact of the new regulatory package. At a minimum, we expect the new rules will cover best practices for exchanges, custody, and lending. They will also address issues related to consumer protection, operational resilience, and data reporting.

Why it Matters

While the past decade has been littered with governments making promising gestures that ultimately end up hindering innovation, there is reason to believe that the momentum in the U.K. could prove more meaningful to the long-term prospects of the ecosystem. Unlike the U.S., where the separation of powers complicates legislative action, the U.K.’s parliamentary system enables the party in power to act decisively. The new rules probably will not be delayed by partisan divisions. The U.K. has a long history of using policy innovations to further their global leadership in financial markets and well defined processes for making and updating financial regulations.

What Comes Next?

  • The consultations announced today will likely move quickly. The government has committed to collect input from the public by April 30.
  • Guidance on how to participate in the consultation is available here. We encourage members of the community to take part in the process. Policymakers want perspective on how to build a smart, successful framework to support economic growth and future innovation.
  • The government will likely seek to have comprehensive rules in place for both businesses and consumers by early next year.

The rulemaking in the U.K. represents the country’s first big effort to reshape its financial sector in the aftermath of Brexit. This broader package of reforms and regulatory updates will be critical to both the U.K.’s economy and London’s future as a financial hub. The bill could finally establish the certainty and clarity that the builders and communities have been seeking for years. If that happens, London may emerge as a destination of choice for web3 projects.

The new rules could also empower specific regulatory agencies—the Financial Conduct Authority and Payments System Regulator—to provide oversight for the sector. The Bank of England may get new powers to regulate the use of digital assets for payments and stablecoins. In the same way the Telecommunications Act passed by the U.S. in 1996 was grounded in a policy commitment to make the America a global leader in innovation, the new rules in the U.K. are based on a commitment to make the U.K. a global leader in the next generation of finance and technology innovation. Again, it is still too soon to speak with certainty about the ultimate outcome, but it’s a hopeful ambition that stands in contrast to the current posture of many regulators in Washington.

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